When settling a personal injury case, you may be given the option of choosing between a structured settlement or a lump-sum payment. While both options provide compensation, the way they impact your taxes can differ significantly. Knowing the tax implications of each choice can help you make a more informed decision. A lawyer, like a tax lawyer, can help you understand how taxes apply to these different settlement structures.
What Is A Structured Settlement?
A structured settlement is a type of payment plan where the injured party receives compensation over time, typically in the form of periodic payments. These payments can be spread over many years, sometimes even for the rest of the recipient’s life. Structured settlements are often set up to provide a steady income stream, which can be particularly useful for someone who has long-term medical or pain-relief needs or who may not be able to manage a large lump-sum payment.
What Is A Lump-Sum Payment?
In contrast, a lump-sum payment is a single, one-time payment of the total settlement amount. This option gives you immediate access to the full amount of the settlement, allowing you to use the funds as you see fit. While a lump-sum payment may be appealing for its flexibility, it can also come with significant tax implications that you need to consider before making your decision.
Tax Treatment Of Structured Settlements
One of the biggest advantages of a structured settlement is that the majority of the compensation you receive is typically tax-free, especially if it’s for physical injury or sickness. The IRS generally does not tax the part of the settlement that compensates you for your injury-related medical expenses, pain and suffering, or emotional distress related to a physical injury.
However, if the structured settlement includes interest or is designed to cover lost wages, the interest portion of the settlement could be taxable. Also, if the settlement involves compensation for non-physical injuries, such as emotional distress not linked to a physical injury, the IRS may tax that portion of the award.
A key benefit of the structured settlement is that because the payments are spaced out over time, it can be easier to plan for the tax consequences. You won’t face a large, lump-sum tax bill in one year, and the periodic payments can help you manage your tax situation as they come in.
Tax Treatment Of Lump-Sum Payments
Unlike structured settlements, lump-sum payments are typically paid all at once. This can have a different tax impact, as you are required to report the full amount of the settlement in the year you receive it. If the settlement includes taxable amounts, such as lost wages or punitive damages, you may face a larger tax liability in the year you receive the payment.
For example, if your settlement includes compensation for lost wages, those funds will be taxed at your ordinary income tax rate. If the settlement includes punitive damages, these are also taxable, regardless of whether they are related to physical injury. Depending on the size of your lump sum, you could find yourself in a higher tax bracket, which could result in a significant portion of your settlement going to taxes.
However, a lump sum also offers flexibility. If you have a financial plan in place and are able to manage your funds effectively, you can use the lump sum to make investments that may help offset the tax impact, or you can pay your taxes upfront and avoid potential future complications.
Consulting A Lawyer For Help
Whether you choose a structured settlement or a lump-sum payment, consulting a tax professional is a smart move. A tax lawyer can help you understand the potential tax implications based on your settlement details and financial goals. They can also advise you on strategies to minimize taxes, such as setting up trusts or tax-deferred investment accounts, depending on the structure of your settlement.
Attorneys like those at Crepeau Mourges can work with you to help you weigh the pros and cons of each option and guide you through the decision-making process. They can also help you plan for any potential tax liabilities down the road, ensuring that you stay compliant with tax laws and make the most of your compensation.
